With real estate investing rebounding to near pre-pandemic levels, it is now more important than ever to consider the benefits of entering into and properly structuring a real estate joint venture.
What is a real estate joint venture?
At its most basic, a real estate joint venture is an agreement between two or more parties to combine resources and expertise to develop a real estate project. The parties to a joint venture are typically a capital investor – who has equity to invest – and an asset manager – who has local real estate knowledge and expertise.
A capital investor and asset manager may look to form a real estate joint venture when there is:
A land contribution: an investor owns property without a clear specific idea of what or how to develop it and chooses to contribute (rather than sell) the property to a developer who has a clear strategy for how to develop the property.
A lack of expertise: an investor has a specific project idea in mind but lacks the expertise to properly develop and manage the project.
An established relationship: when a developer has a pre-existing, established relationship with a quality tenant who is looking for newly built property to lease but lacks the means to develop the property.
Methods to structuring a real estate joint venture:
There are several ways to structure a real estate joint venture, but the most common methods include:
Contractual joint venture: this method involves the parties to the joint venture entering into a contract which establishes the terms of their agreement. The contract will typically include details of each party's financial commitment and duties in relation to the development project. As the parties negotiate the terms of their agreement, contractual joint ventures are generally considered to be quite flexible and responsive to each party's respective needs. One of the biggest disadvantages to a contractual joint venture, however, is that because the parties have not formed a separate legal entity, the parties may face unlimited liability in relation to any losses incurred by the venture.
Special purpose vehicle companies (SPV): structuring the joint venture as an SPV requires the parties to form a limited company which is set up for the specific purpose of carrying out the joint venture (this is often referred to as the joint venture company). The key advantage to setting up an SPV, rather than a contractual joint venture, is that its shareholders (the parties that have set up the SPV) have limited liability, meaning that the risk of the venture for the parties can be restricted.
Limited Liability Partnership (LLP): in simple terms, structuring a joint venture as an LLP means that the parties have formed a separate legal entity that can contract directly with third parties, hold property, grant security over its assets and sue and be sued. Further, because LLPs are separate legal entities, they also afford their members (the JV partners) limited liability. It is also worth noting that LLPs are tax transparent, meaning that the joint venture partners are taxed directly on their respective shares of the LLPs' profits and losses, that LLPs are subject to the Limited Liability Partnerships Act 2000 and that LLPs are required to file accounts.
Advantages of real estate joint ventures:
Some of the key advantages of real estate joint ventures include, but are not limited to:
Combined expertise: the saying two heads are better than one applies quite appropriately to joint ventures. The parties can use their unique skillsets and expertise to share (and hopefully lessen) the burden of developing and operating property.
Sharing the risks: if the joint venture were to fail, neither the capital investor nor the asset manager – as partners – is alone in bearing the costs of its failure.
Access to foreign markets: forming a joint venture with an established domestic developer may provide foreign capital investors with an opportunity to break into other markets.
Disadvantages of real estate joint ventures:
Some of the issues parties face when forming a joint venture include, but are not limited to:
Finding the right partner: a clash of cultures, beliefs and management styles has the potential to sink any joint venture before it even takes off. Finding the right partner may take time and effort but it is essential to the success of the venture.
Negotiating terms: negotiating the terms to a joint venture agreement can prove to be a highly contentious exercise. Areas of particular conflict may include: the distribution of profits, the capital contribution of the parties, management and control of the venture and strategies for exiting the venture.
Potential to limit business opportunities: it is often the case that joint venture contracts restrict the ability of its parties to pursue business opportunities outside of the joint venture whilst work on the venture is still ongoing. It is therefore extremely important for the parties to consider their other business interests when agreeing to enter into a joint venture.
A joint venture between a capital investor and an asset manager has the potential to offer a substantial benefit for both parties. Combining the capital investor's equity investment with the asset manager's knowledge of the real estate market and expertise can allow both parties to truly maximise their respective returns on their investment.
For more information or advice on real estate joint ventures please contact either Charlotte Whitworth or Jonah Cohen at Howard Kennedy LLP.